Assessment of the risk of bankruptcy of the enterprise

Mar, 03 2022

Contents:

When the company becomes unprofitable and cannot pay off all obligations, the owners initiate bankruptcy proceedings. It implies the liquidation of the business and the payment of debts as much as possible.

For effective business, it is important to assess the risk of bankruptcy of the enterprise in a timely manner. In other words, it is necessary, based on objective data, to predict the probability of such a development of events, in which the only way out of the situation will be to declare the company bankrupt and liquidate it.

Indicators of bankruptcy risk

It is impossible to say with 100 percent accuracy which business will go bankrupt, and which will not. However, it is possible to objectively assess the probability of such an event based on certain signs. The assessment of the risk of bankruptcy of an enterprise is a quantitative diagnosis that allows avoiding financial problems in advance.

The most obvious indicator indicating problems within the business is many debts that continue to accumulate, in the absence of an opportunity to pay them off. In such a situation, managers may hide the actual situation to bring the company to deliberate bankruptcy – it is difficult to identify such plans without an independent audit.

Timely audit is also important because the main reason for the liquidation of companies is the financial crisis. Various factors can lead to it: inefficient management of borrowed capital, the company receiving loans that are larger than its own funds, overdue receivables and much more.

The indicators of bankruptcy risk, which should make management wary, also include the presence of unprofitable departments and production, a decrease in sales and investments.

Types of bankruptcy

  • Regional. It is directly related to the specifics of the regions of sales or provision of services. For example, the regional type of risks is formed by factors such as the development of local infrastructure, the presence of production facilities or a distribution network in a certain area.
  • Industry-specific. This type of risk is associated with factors such as demand, competition, and pricing policy. It can be influenced by the political situation, decisions of the state apparatus: all external and internal circumstances that form the sales market and the cost of goods / services.
  • Macroeconomic. This type of risk is associated with external factors that the corporation cannot independently influence market stability, taxation, banking, inflation, and much more.

The calculation of the bankruptcy risk requires considering all factors to objectively assess the situation. At the same time, from the point of view of creditors, declaring bankruptcy does not always have only negative consequences, because they get the opportunity to return at least part of the funds. Another question is that it is not often possible to recover the debt in full of a bankrupt enterprise.

Methods of assessing the risk of bankruptcy of a corporation

Independent experts should assess the probability of financial collapse. This is a complex, complex procedure that requires considering many factors. Therefore, entrust the audit to professionals. They will choose the optimal models and methods for calculating risks – there are a great many of them, both domestic and foreign.

For example, specialists can use a quantitative method to calculate. It consists in collecting and analyzing financial indicators that are compared with the standards. At the same time, experts always look at the dynamics of changes in these indicators, for example, over the year.

There is also a qualitative method that relies on indirect signs indicating the solvency of the company. But most often, specialists’ resort to a mixed method that combines quantitative and qualitative criteria. This is how auditors get the most complete picture of the financial situation of the business.

Risk calculation also involves the use of absolute and coefficient models. The first type of methods is based on data on fixed and working capital. The second type of models requires the calculation of relative indicators. Auditors can evaluate individual factors that are not related to each other or calculate a whole set of factors by comparing how they have changed over time.

In some cases, specialists create a special model for analyzing the financial condition of an enterprise and the risk of bankruptcy. This approach allows you to get the most complete and objective picture, consider the specifics of the industry, the macroeconomic situation, and the state of the business.

Risk prevention

It is necessary to be aware of the risks to respond effectively to them. Having identified a weakness or flaw in the financial system, it is important to take certain measures and develop strategies that will help avoid problems in the future. At the same time, the corporation can choose a strategy for avoiding or reducing risks, transferring, or accepting them.

Risk avoidance, as a rule, implies abandoning a certain type of activity, entering the market. Risk reduction requires comprehensive measures within the enterprise itself, and transition means, for example, insurance. Also, a business can consciously take certain risks because the very probability of financial problems does not mean that they will surely begin. However, such a strategy as acceptance is justified only in the case of small risks.

There are also risk management tools: when you know about the danger and are ready to take certain steps to prevent it. One of these tools we have already mentioned is insurance. It allows you to compensate for material damage in case of an unsuccessful development of events. If the risk cannot be transferred, you can resort to such a tool as reservation or distribution between the participants of the transaction.

When price risks are transferred from one company to another, this is called hedging. The allocation of investments and liabilities to reduce financial risks is diversification. Finally, it is worth mentioning such a tool as minimization: when you keep the balance of assets and liabilities so that the net value of the portfolio does not fluctuate too much.

It is also worth considering such a risk management strategy as operation. It is considered separately from other strategies and tools because it is suitable exclusively for situations where the likelihood of problems is associated with a positive impact on the business. How is this possible? For example, the demand for your products will grow to such an extent that the company will not have time to process and ship orders. This will cause a wave of customer dissatisfaction, but it is still associated with positive changes.

When positive risks arise, the company should not seek to avoid them, but should use them. Experts recommend looking for ways to make a risky situation happen and even strengthen its effect. Of course, in this case, the business should have an action plan. This can be an algorithm for rapid recruitment and training of personnel, optimization of mechanisms for shipping goods, and so on.

You should think about risk prevention already at the project launch stage. It is important to predict possible difficulties and dangers in advance, to create algorithms of actions in case of risks. It is equally important to review your own strategies and risk assessments from time to time, because external and internal circumstances change.

Improvement of the enterprise

Financial recovery is one of the stages of bankruptcy, the decision on which is made after observation and analysis of the possibility to restore the solvency of the company. The recovery procedure begins with a creditors’ meeting approved by the arbitration judge. At the meeting, an application is considered, to which the initiator attaches a recovery plan and a schedule for repayment of debts, the minutes of the meeting and information about the company’s reserves.

Considering the possibility of securing guarantees from the debtor, the meeting assesses the situation and decides on the beginning of the rehabilitation procedure. At the same time, it cannot last more than two years, and throughout the entire time the company is managed by an administrative manager who maintains active interaction with creditors.

The procedure depends on the proposed plan. It may include the search for investors, closing unprofitable production, changing the profile of the company, attracting new specialists. Recovery may even require the launch of advertising campaigns and professional development of employees. The procedure ends with the implementation of the plan and a report on the results, after which the company goes under external management.

Conclusion

Timely calculation of bankruptcy risks helps to avoid critical situations when the only solution will be the liquidation of the enterprise and the payment of debts. At the same time, risk management inevitably focuses on threats and dangers, which sometimes conflicts with the philosophy of entrepreneurs. But even if you tend to focus on opportunities rather than threats, it makes sense to calculate the risks in advance and assess how much you are willing to put up with them.

Entrust the risk assessment to independent specialists who will conduct a comprehensive analysis of the situation and propose an effective management strategy. It is worth assessing threats to business regularly, because not only internal, but also external processes can pose a danger.

Author of the article
Assessment of the risk of bankruptcy of the enterprise
Valentina Khlavich
Managing Partner
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